Financial News for the Week of February 24th, 2023

Not all economic data was positive this week, but a strong rebound in consumption and evidence of sticky inflation continued to build the case that the Fed will take the policy rate higher in financial news. Rising Treasury yields took a toll on equity markets, with the S&P 500 down 3.3% from last week’s close (at time of writing).

A second reading on fourth-quarter GDP showed that the U.S. economy ended 2022 on softer footing than previously reported. The headline measure was revised down from 2.9% quarter-on-quarter (q/q) annualized to 2.7%. Net exports and inventory investment, two inherently volatile components, continued to make up the bulk of gain, while final sales to private domestic purchasers – a measure of underlying domestic demand – was downgraded from 0.2% to an even softer 0.1%. This as consumer spending was shaved down noticeably from 2.1% to 1.4%.

However, January’s personal income and outlays report showed that consumer spending rebounded strongly to start the year. Real consumer spending rose 1.1% month-on-month (m/m) in January, reflecting gains in both goods and services. Following in the footsteps of a strong retail sales report, real goods spending rose a sharp 2.2% (m/m), while services spending rose 0.6%. Overall, this is a very good start to first-quarter consumption, which we anticipate will expand in the 1.5-2.0% (q/q annualized) range in financial news. A tight labor market, which is helping support healthy growth in wages and salaries, will also help in this regard.

The above report also provided an update on inflation. Total PCE inflation accelerated to 5.4% year-on-year (y/y) from 5.0% in December. The Fed’s preferred inflation gauge, core PCE, accelerated modestly, rising to 4.7% y/y from an upwardly revised 4.6% in December. The key point to highlight here is that core PCE inflation looks to have picked up some steam recently (Chart 1).

The fact that inflation is showing signs of stickiness and that the labor market remains hot, raises the odds that the Fed will need to take the policy rate higher and perhaps keep it there for longer. Minutes from the latest FOMC meeting, which showed members’ resolve to keep fighting inflation through additional rate hikes based on incoming data, helps further cement this view. Marked odds still favor a rate hike of 25 basis points (bps) at the March meeting, but odds for a 50-bps hike crept higher following the PCE report and are hovering around 33% as of writing.

Among other things, a “higher for longer” policy rate, means that there could be additional fallout for interest-sensitive areas of the economy. On this front, existing home sales fell again in January (-0.7% m/m), extending the losing streak to 12 consecutive months. Since interest rate changes tend to influence sales activity with a lag, past declines in mortgage rates could drive some improvement in sales over the near-term. But given that mortgage rates turned higher again, housing activity will continue to be tested. High frequency data second this view, with mortgage purchase applications falling to a 28-year low last week (Chart 2). Indeed, it appears that the start of a new and improving trend in housing is still some time away.

 

Admir Kolaj, Economist | 416-944-6318